What is a Macro Investing Strategy? Understanding the Critical Factors that Drive Returns in Your Portfolio 

• A global macro approach to asset allocation takes fiscal and monetary conditions into account while carefully analyzing asset classes and sectors

• Risk is constantly being managed along with a focus on inflation and geopolitical shifts

• Above all, you want to build and maintain a durable portfolio that can withstand inevitable bearish shocks while participating in bull markets

The phrase “macro investing” gets tossed around haphazardly in today’s financial media. Lost in the noise is its real meaning – a strategy that focuses on broad economic and political trends to make asset allocation decisions. Ray Dalio, founder of Bridgewater Associates and among the best thought leaders on macro strategy, offers a comprehensive framework for how to analyze all the crosscurrents affecting stocks, bonds, commodities, and other asset classes. 

Allio believes there are key drivers of opportunity, risk, and long-term growth in today’s markets. By adopting a macro approach, you can take control of your wealth and build a resilient portfolio over time. The key is to identify trends before they become mainstream and to always be on watch for cycle changes to manage risk.

Let’s dive into what a macro strategy is and why it matters for all investors today. We’ll have to lay the groundwork by calling out certain facets that shape today’s economy. From there, the seven major asset classes and 11 market sectors will be analyzed from a portfolio perspective. Throughout this guide, reminders of Dalio’s principles will be reinforced so you can tap the wisdom of the greatest hedge fund manager of all time. 

Allio’s team of portfolio managers and analysts harness these methods to help investors grow their wealth with Allio’s Managed Macro investment portfolios, while our tools, which include Allio’s Macro Dashboard, are designed to help investors keep an eye on geopolitical and financial risk to make sure they stay ahead of the curve.

Fiscal and Monetary Policy: The Foundation of Macro Investing

Markets are increasingly sensitive to how fiscal and monetary conditions turn. 

Lets start with a quick refresher on monetary and fiscal policy which we hope is helpful for novices and experts alike. We’ll start with the basics and then connect these concepts to how they relate to risk assets, portfolio construction and asset allocation.

Fiscal Policy

The government’s fiscal policy has the power to pick winners and losers across industries. For example, if NASA is fielding requests for a new heavy lift rocket, they can potentially award that contract to either Boeing or SpaceX. Whoever they choose will receive billions in marginal revenue while the other may not receive anything. When the legislators control trillions of dollars, even modest decisions can turn depressed corners of the economy into thriving niches. 

Fiscal policy refers to government spending and tax policies used to influence the economy. It used to be that when a recession occurred, the federal government would provide stimulus by way of tax breaks and increased spending to spur GDP growth, particularly with the consumer. Then, during the boom times, Congress in the US would tighten its purse strings by raising taxes and reducing spending, thereby pumping the brakes on the economy so it doesn’t overheat.

Today, however, fiscal restraint is non-existent. We’ve witnessed governments around the world continue excessive spending despite decent growth trends post-pandemic. Look no further than the US national debt which soared 30% under President Biden – a four-year period that was entirely after the worst of the COVID-19 pandemic. So, the risk all investors must consider is how many bullets governments across the globe will have left when the next inevitable downturn begins. Their only choices will be to raise taxes (which would be politically unpopular and threaten lawmakers’ careers) or lean on further deficit spending. 

Either outcome could be perilous. In recent cycles, we have seen the negative effects of austerity in Europe and excessive spending in the US. Weak economic growth and stubbornly elevated unemployment across the Euro Area during the 2010s reflected the downside of high taxes while inflation in the US in the wake of the pandemic wreaked havoc on consumer sentiment, leading to the red wave of 2024.

Fiscal policy is critical to understand in today’s environment. Global debt has soared, and interest rates are much higher than they were in the last decade. Even modest shifts in government spending and tax policy can have a dramatic impact on stocks, bonds, and market discount rates. The good news is that there are asset classes and sectors that can benefit from heightened fiscal uncertainty. Stay tuned on that front.

Monetary Policy

While politicians generally control spending and taxes, a country or region’s central bank determines interest rate policy and the flow of money through an economy. Indeed, changes to the money supply and how accommodative or restrictive monetary policy is may fuel or halt bull and bear markets in stocks. In the current environment, equities take their cue from the bond market, so what the Fed, European Central Bank (ECB), Bank of Japan, and Bank of England, among others, decide at each of their respective meetings is crucial to ebbs and flows across asset classes. 

Central banks are tasked with setting or influencing interest rates to manage the money supply. The Fed, for instance, has the dual mandate of price stability and maximum employment. In the background, the Fed aims to keep the financial system stable, protect consumers, ensure an efficient payment system, assist with federal spending operations, and offer banking services throughout its 12 districts. The ECB, by contrast, focuses more on inflation, which can result in more volatile growth trends overseas.

Each time the Fed adjusts its policy rate, it makes the evening news. Its other activities are less in the spotlight. Under the monetary policy umbrella are open market operations (the buying and selling of government bonds) and adjustments to bank reserve requirements. Both tools impact the money supply and, hence, inflation, employment, and overall economic stability. Just as cutting interest rates spurs GDP growth, buying government bonds and reducing reserve requirements effectively stimulates an economy. If GDP and inflation run too hot, hiking interest rates, selling bonds, and increasing reserve requirements are restrictive measures to prevent high and unstable growth.

On net, both fiscal and monetary policy are powerful tools for policymakers to shape an economy. Their decisions impact asset prices, interest rates, inflation, and overall sentiment. For you as an investor, you must keep abreast of what’s happening at the Fed and within Congress (and other nations’ authorities) to manage risk and identify macro trend changes. Allio makes this easy with their Macro Dashboard, which is designed to help investors monitor and react to changes in the macro landscape in real time.

Macro Cycles and Regimes: Dalio's Big Cycle Framework

Armed with fiscal and monetary policy acumen, you can better understand how a macro strategy is molded using Dalio’s principles. The Big Cycle plays out over decades and often dictates the overall health and direction of an economy. All markets are primarily driven by just four determinants: growth, inflation, risk premiums, and discount rates. Together, the following determinants form regimes that foster bull and bear markets within asset classes:

1. Growth

Macro strategy and asset allocation hinge on an economy’s growth prospects. A quality educational system, technological prowess, cost competitiveness, military strength, favorable trade policies, high economic output, leading financial markets, and, above all, reserve-currency status support robust economic potential. These eight key measures of power shape a country’s growth trajectory. Nations gaining prominence can be overweighted in a portfolio via ETFs. What's more, sector allocation can be optimized based on whether a country is on the rise or in decline.

2. Inflation

Understanding inflation trends and their impact on intermarket relationships is required to successfully navigate powerful economic trends. Inflationary periods often favor exposure to areas like commodities, energy, gold, and real estate. We’ll discuss sector positioning later, but the key thing here is to recognize that the macro regime can flip quickly from inflationary to deflationary, particularly on a country-by-country basis. When the focus is on fighting deflation, equities and fixed income usually move opposite of each other while central banks aggressively buy bonds and reduce policy rates to fuel growth. Too much money printing may result in stubborn inflation when the cycle turns.

3. Risk Premiums

The foundational level of Dalio’s building blocks of a diversified portfolio is comprised of risk premiums and discount rates. Risk premiums represent the excess return investors demand from holding a risky asset, such as stocks, compared to risk-free assets, like Treasury bills. During bull markets and when sentiment is high, that excess return requirement may be small, enticing investors to buy stocks even when P/E multiples are lofty. When volatility strikes and amid protracted bear markets, the risk premium turns high. Even long-term investors might shy away from equities when the risk premium approach asserts that owning stocks is the right move. It’s at times like this when understanding that macro regimes shift and cycles evolve is valuable. 

4. Discount Rates

Along with the importance of risk premiums, discount rates impact asset prices. For stocks and bonds that have valuations dependent on the present value of future cash flows, the greater the discount rate, the lower the intrinsic value. It’s just math. Unfortunately, the herd fails to whip out their collective calculator when euphoria reins around market peaks and when despondency rules at the depths of a bear market. It often makes little sense to see a stock market trade at a single-digit P/E when rates are under 3%; rotating into stocks is mathematically the right strategy then. On the flip side, when stocks trade north of 20- or 25-times forward earnings estimates while government bond yields are 5% or more, then taking a defensive stance is prudent.

The Building Blocks of a Well-Diversified Portfolio

Dalio’s Big Cycle and Determinants

Source: Principles for Dealing with the Changing World Order: Why Nations Succeed and Fail (all charts courtesy of this book unless otherwise noted)

Inflation and Geopolitical Risks

Each of the four determinants is impacted by inflation and geopolitical developments. Dalio constantly returns to these factors when describing current markets. Inflation erodes the purchasing power of money over time; it is the most important reason you should always be invested in something. Whether it's stocks, bonds, interest-earning cash, commodities, real estate, gold, or cryptocurrency, ‘real’ returns are required to maintain purchasing power. Sure, inflation at 1% or 2% has little impact over a year or two, but over decades and when inflationary periods strike, the compounded impact is massive. In the US, the inflation rate has averaged 3.3% since 1914. That means a dollar’s true value is cut in half every 22 years. To thwart inflation’s sting, staying invested in a macro portfolio can be beneficial.

The appeal of stuffing your money under your mattress is high when fear permeates, often driven by geopolitical tensions. We commonly see conflicts in the Middle East and hot wars between adversaries on the global stage, but increasingly it’s cold riffs and trade wars that can rock economies. This version of geopolitical turmoil is the lynchpin to how the Big Cycle, as Dalio coins it, unfolds. Emerging nations with strong leadership, effective resource allocation, quality education, and cultural ties are well-positioned to take on declining world powers – internal order is crucial. Old World Orders that have neglected fiscal discipline, resorted to excessive money printing, are riddled with internal conflict, and lack prominent leaders leave themselves vulnerable to attack, be it via armed physical invasions or acute financial gamesmanship.

Together, high and rising inflation along with heightened geopolitical risks put upward pressure on discount rates, thereby lowering the fair value of assets priced on future cash flows. Moreover, just the fear of worsening macro conditions may lead to reduced consumer spending and corporate investment, thereby pressuring earnings and market valuations. Stocks broadly trend higher, of course, so staying level-headed even when the macro picture shifts darker is imperative.

Forming Your Portfolio: Identifying Asset Classes

It’s not enough to have even an expert-level knowledge of the macroeconomy; the textbook and even Ray Dalio’s insights mean little if you cannot form a portfolio and manage risk. The first step in the process of turning into a macro asset allocator is to know the seven asset classes and how they influence each other.

1. Stocks

Stocks have the best long-term returns among all asset classes. They are claims on real assets and cash flows of companies, and generally perform well in periods of economic expansion. A rule of thumb is that a diversified equity sleeve should produce a positive return in three out of every four years. Dividends included, a global stock portfolio has returned about 9% per year. After inflation, that’s more like 6%. The US has been a stand-out country in the past century, so it has delivered a higher compounded return. 

But those sanguine aggregate numbers fail to highlight the reality that most country markets endure devastating losses when the macro situation turns for the worse. Drawdowns upwards of 90% are the norm, some of which are never recovered from.

2. Bonds

Bonds are commonly seen as the ballast to a diversified portfolio. That works fine when stock and bond prices move opposite of each other, but inflationary regimes cause trouble for fixed income. Interest rates increase when inflation fears mount, leading to bond losses. Rising debt levels brought about by unstable fiscal and monetary policies not only result in ascending yields, but may also stoke inflation. And since bonds are nominal assets, they have no inflation protection (outside of TIPS). 

You want to own bonds when inflation is held in check and the long-term interest rate trend is down, and that often coincides with a country that is on the rise with stable fiscal trends within the Big Cycle.

3. Cash

Stocks and bonds comprise the majority of most investor assets; cash is usually relegated to near-term spending needs. Thus, it’s more of a personal financial choice rather than a strategic portfolio position. Cash is your dry powder, however, when other asset classes present favorable risk/reward opportunities. It is also a viable holding when interest rates are high and steady while inflation is low. 

Cash is king during economic turmoil and as the yield curve becomes inverted – when short-term interest rates are above long-term rates. Cash is trash, though, when inflation is high and taxes are punitive; many investors fail to recognize that cash loses purchasing power due to a rising cost of living and when interest income is snatched by taxing authorities (the tax rate on interest is higher than it is on long-term gains in stocks). Not factoring in taxes, interest-earning cash has historically outperformed stocks in about 30% of all years, but over a 25-year period, there hasn’t been one instance in which cash beat the S&P 500.

4. Real Estate

Real estate works best when interest rates fall, but can also perform well during inflation. The twist is that rates and inflation often move in tandem. So, while physical assets like homes and commercial properties may appreciate during inflation, higher borrowing costs and discount rates may hurt real estate valuations. REITs and the Real Estate sector come under pressure when rates are high and rising. For many people, owning a home with a fixed-rate mortgage is the ultimate inflation hedge, so adding extra real estate exposure may not be necessary.

5. Commodities

Commodities, like energies, agriculture products, and metals, can be solid inflation hedges. We typically see that commodities and interest rates move up together during inflationary periods, while stocks and bonds may suffer. Thus, this asset class can be an effective portfolio hedge. Amid deflation, however, decades can pass in which a broad commodity index underperforms global stocks. Individual commodities are also subject to idiosyncratic supply and demand changes that can result in skyrocketing prices or crashes. You might even see negative spot prices, like was seen in crude oil in April of 2020.

6. Gold

Dalio views gold as a key component of a well-diversified portfolio. Over many centuries, it has weathered all macro cycles, acting as a hedge against currency devaluations and geopolitical risks. Quantitative analysts try to create the perfect formula for gold’s performance, but it can work during inflation, deflation, growth, recession, and good times and bad times. 

Big picture, macro uncertainty is usually a tailwind for precious metals. Excessive money printing by central banks and loose fiscal policy cause investors to flock to gold’s stability too. The yellow metal often rallies when war breaks out as well. On the other hand, steady real interest rates, fiscal and monetary soundness, and periods of peace around the world may cause gold to fall out of favor. Finally, gold’s long-run return pales in comparison to stocks, so you must be careful with your portfolio positioning to it.

7. Crypto

We mentioned earlier that stocks have the best long-term returns. Crypto, namely bitcoin, claims the top spot when it comes to short-run performance. While not explicitly mentioned in Dalio’s earlier writings, cryptocurrency has emerged as its own asset class. Seen as digital gold, bitcoin specifically has a finite supply of 21 million coins and can act as a defense against currency devaluation. Volatility is tremendous, though, so considering even the biggest crypto assets, such as bitcoin and ether, as stores of value is a stretch. Crypto’s market worth is just a few percent of the global stock market, so position sizing is once again important here.

The Impact of Macro Forces on the 11 Sectors

Let's home in on the 11 stock market sectors and how you should weight your portfolio as macro conditions change. Standard & Poor’s and MSCI developed the Global Industry Classification Standard (GICS) in 1999. The structure helps portfolio managers and investors take a top-down view of markets. It consists of 11 sectors, 25 industry groups, 74 industries, and 163 sub-industries. We’ll stay high level and analyze just the 11 sectors. 

The sectors, ranging from Energy and Materials to Information Technology and Health Care, respond differently to various macroeconomic conditions. Let’s break down how each area typically behaves under different regimes:

1. Information Technology (25% of the All-Country World Index)

Tech has historically been the prototypical growth sector. It does best when interest rates fall, and stories of innovation drive the narrative. Some of the biggest companies in the sector today are not like leveraged companies of yesteryear, however. They have ample cash on hand and formidable balance sheets, making them less susceptible to rising interest rates. Still, geopolitical instability can hurt the I.T. sector due to its international exposure, while a rising dollar can be a headwind.

2. Financials (17%) 

Financials is the second-biggest sector in the global stock market. The performance of banks and other financial institutions is tied to interest rates and economic growth. Thus, it’s much more cyclical whereas tech is secular. Rising rates generally help banks, along with steepening yield curves. In periods of macro instability, banks might be among the areas hardest hit, as we saw during the 2008 Great Financial Crisis. 

3. Consumer Discretionary (11%)

Consumer Discretionary is among the easiest to understand among the 11 sectors. It performs best when real wages are on the rise, sentiment is high, and economic growth prevails. When the jobs market is strong, people make more money, leading them to spend more, which helps the sector’s companies generate earnings, fueling the stock market, which adds to the so-called wealth effect. When the cycle is disrupted, consumers pull back on non-essential spending and the sector struggles. 

4. Industrials (10%)

Another area of the stock market that depends on the macroeconomic situation is Industrials. It relies on business investment and consumer spending, two areas sensitive to interest rates. Higher borrowing costs crimp capital spending, which negatively impacts areas like capital goods, transportation, and multinational manufacturing. Industrials is most coincident with the economic cycle, meaning it bottoms at the depths of a recession and its peak commonly marks the top of an expansion. Industrials performs best during the middle of a bull market. 

5. Health Care (10%)

We’ve touched on how tech is secular and noted the cyclicality of Financials, Consumer Discretionary, and Industrials. Health Care, however, is defensive. The demand for medical products and services is relatively stable regardless of macro conditions. However, the group is highly at risk from regulatory and legislative policy shifts, particularly when power changes hands at the federal level. Pharmaceutical firms broadly have lower betas, but biotech stocks can be among the riskiest in the market.

6. Communication Services (8%)

Communication Services is a new sector. It used to house telecom stocks, but it’s now broader to include media and entertainment companies. Though it depends on consumer spending and a growing economy, it’s less cyclical than, say, Consumer Discretionary, but not as much of a secular grower compared to Information Technology.

7. Consumer Staples (6%)

As we venture further down the size spectrum, Consumer Staples is your tried-and-true blue-chip niche of the global stock market. Food & beverage firms and household goods companies are less affected by economic cycles. They can also be an inflation hedge as consumer spending in this category doesn’t stray far from the overall price level. Very defensive, staples perform best during bear markets but underperform during bull markets.

8. Energy (4%)

Oil & gas stocks make up the Energy sector. They are very dependent on spot and futures prices of crude oil and natural gas. Energy is unique in that it can be the only winning sector when war breaks out and inflation soars. Thus, there are periods when it’s the ultimate equity risk diversifier, but the downside is that Energy’s valuation can turn very depressed during disinflation and when fears of deflation permeate investors’ psyche.

9. Materials (4%)

Energy and Materials are the two resource sectors. Both can work well when the dollar declines, but that is not a hard and fast rule. Materials includes companies that mine for and/or produce metals, chemicals, and other natural resources. It’s highly cyclical, and supply shortages or surpluses cause big profit swings among the sector’s constituents. 

10. Utilities (3%)

Utilities is the most boring of the 11 sectors. It’s just true. Like Health Care and Consumer Staples, it’s very defensive. People need electricity, water, and gas regardless of the macro cycle. You may want to overweight Utilities when interest rates fall and as economic optimism dims. Power-generation companies, in particular, are highly leveraged since their businesses are so stable, so rising interest rates can lead to lower earnings.

11. Real Estate (2%)

The smallest and newest GICS sector is Real Estate. Interest rates and inflation matter big time for Real Estate Investment Trusts (REITs) and property stocks. Income investors flock to Utilities and Real Estate, so when Treasury yields jump, competition grows between interest rates and dividend yields, leading to lower equity valuations in many instances. The upside is that physical real estate can act as an inflation hedge.

Building a Macro-Informed Portfolio

The best portfolio is one that you can stick to when macro conditions inevitably go awry, but you also don’t want to fall victim to FOMO in bull markets. So, constructing the right asset allocation depends on how much return you require and your ability, willingness, and need to accept risk. Dalio’s approach emphasizes diversification across asset classes and sectors without sacrificing long-term return potential. You’ll want an allocation that can participate in bull markets, perform well in bear markets, and retains real value in the worst periods. You can only achieve that by investing across asset classes and always monitoring macro conditions.

To implement such a strategy, begin by analyzing macro indicators for clues on cycle changes or mere perturbations in intermarket relationships. For example, if oil prices break out and geopolitical jitters arise, then going overweight the Energy sector and commodities have the potential to provide strong risk-adjusted and relative returns. In another situation, if unemployment spikes and the central bank is aggressively cutting interest rates, the time might be right to prepare for a market bottom by going long the Information Technology and Consumer Discretionary sectors. Remember: Being a savvy macro investor means staying ahead of the curve. Recall that the perfect time to aggressively buy stocks was in Q1 and Q2 of 2009 and March of 2020 – two periods when the jobless rate was the highest.

Longer-term, macro investors must always keep an eye on national debt levels and how that can impact interest rates. That, in turn, causes trends to shift across asset classes. From there, sector analysis helps to home in on specific tilts, while spreading investments across geographic areas may further reduce portfolio risk. Perhaps the biggest skill is simply having the temerity to adapt to changing macro regimes. Stubbornness usually works to the detriment of investors, so effectively balancing risk and return demands that you be nimble in the short term while vigilant to long-run trends.

The Bottom Line

Ray Dalio’s macro investing framework offers a comprehensive guide to navigating today’s financial markets. Fiscal and monetary policies play important roles in how the global investing landscape unfolds. Cycles constantly evolve, inflation worries come and go, and geopolitical risks seem to be a mainstay. All the while, maintaining portfolio discipline and adapting to all the macro determinants is critical. 

Allio’s macro-investing philosophy focuses on all the major factors influencing today’s markets. We empower investors to take control of their asset allocation, allowing them to think big picture, act decisively, and stay ahead of the curve. By leveraging Allio’s institutional-grade tools, investors can more confidently navigate the next macro cycle.

For example, Allio’s Dynamic Macro Portfolios are designed to help investors participate in bull markets and play defense in bear markets. Our curated menu of investment choices along with our Macro Dashboard puts you in the driver’s seat to control your financial future. Allio users can add, remove, and rebalance investments for maximum personalization, all with the confidence of knowing that our portfolio managers will continually monitor their portfolios.

At the end of the day, macro matters most! If you want to stay ahead of the curve, it's time to take a macro approach to following policy and market shifts. Position yourself for success by signing up for the Allio Capital beta today and make sure you're always on top of the trends that matter most.